Aggregate Supply

Question 1

Classical diagram

Answer 1

LRAS is perfectly inelastic - output is fixed in the long run by availability of factors of production, irrespective of the price level

Question 2

Keynesian diagram

Answer 2

LRAS is perfectly elastic at low levels of output and rises to be perfectly inelastic as full employment of resources is reached

Question 3

AS

Answer 3

The quaintity of goods and services that producers in an economy are willing and able to supply at a given price level

Question 4

SRAS

Answer 4

• Is the relationship between planned national output and the general price level
• It shows how much output the economy can generate in the short-term at each price level
• A rise in the general price level should stimulate an expansion of supply
• When prices are falling, production may contract
• The main factor causing shifts in SRAS is the resource cost of producing goods and services

Question 5

Shifts in SRAS

Answer 5

• Supply side shocks can shift the SRAS
• Wage rates - an increase will raise average costs and therefore SRAS shifts left
• Raw materials/ Import prices - A fall would lower firms costs meaning firms would reduce prices causing a shift right in the SRAS - e.g. oil
• Indirect tax - an increase in indirect taxes will increase the cost and shift SRAS left
• Change in productivity - A decrease in productivity will shift the curve to the left - an equivalent to an increase in cost of production

Question 6

Classical view

Answer 6

• The idea that the economy is usually in long run equilibrium and can return to this position after a supply side shock
• This is based on the view that markets will ensure all factors of production are being used
• If there are unemployed resources then the price of these resources will fall until the market returns to equilibrium
• However Keynesian economists disagree with this as they observe in the labour market wages are “sticky downwards” - they don’t fall to clear markets meaning you can have unemployment in the long term
• Where as classical economists say in the LR all unemployment is voluntary

Question 7

Keynesian view

Answer 7

• At full vertical employment the economy cannot produce anymore and the LRAS is vertical
• Mass unemployment - output can be increase in price level (horizontal)
• Unemployment is falling - output can still increase but there is an increase in the price level as firms pass on the extra costs of higher wages in the form of higher price (curved section)

Question 8

Shifts in LRAS

Answer 8

• Keynesian and classical economists agree that the vertical part of the LRAS will shift is there are changes in quantity or quality or resources available.
• In other words changes in the productive capacity of the economy
• An increase would cause a shift to the right in the PPF, and a shift to the right in the LRAS
• Or is there is an increase in technology